Washington Place, the subject real estate project of the course, is a multifamily building in Big Apple City with 20 market rate units–each with 1-3 bedrooms.  It is currently for sale for $25 million.

Sam the Sponsor, the protagonist in our case study and Managing Partner of Koala Capital, will need to raise the necessary real estate funding–both equity and debt capital–in order to acquire Washington Place.  

Before we dive into funding the property and its repositioning strategy, we’ll need to understand why Washington Place is a good subject deal. The key financial information for Washington place is as follows:

• 20 market rate units (1-3 bedrooms) for $22 million
• Current NOI from Washington Place is $1.3 million (buying at a 6% cap rate)
• Sponsor plans to furnish and operate a percentage of units as extended stay
• Total development and construction costs (hard and soft) are $3 million
• The projected NOI once the project is repositioned and stabilized is $2.3 million

The first key calculation when underwriting a commercial real estate property is unlevered yield on cost (UYOC), which is calculated as “NOI divided by total costs”.  This is typically used as the first litmus test for whether a deal is worth pursuing–where anything over a 7% UYOC is typically considered solid for a value-add project like Washington Place.

In this case, once stabilized, the project will produce NOI of $2.5 million on a total project cost of $25 million ($22 million acquisition and $3 million in development and construction costs).  This gives us a stabilized yield of 9% for Washington Place–a great start!

Next, we’re going to assume we can get a loan at 60% loan-to-cost (LTC)–so $15 million of debt capital–at market rate terms.  This leaves us with an equity capital raise of $10 million  And if we execute as planned (stabilize and sell in 5 years at a 6% cap rate), this will generate a 22% IRR for equity investors (solid!).  

Now, the great chicken-egg dilemma ensues: tie up the deal before raising capital; or raise capital before tying up the deal?  The former risks not being able to close on time; and the latter risks losing the deal altogether.

Unless you have a strong existing relationship with an investor, they will always focus more when you show them a specific deal, particularly one that is tied up. Of course, many times it is challenging to tie up a deal if you don’t have an investor.

A couple of practical solutions:

• Show a good deal to an investor even if it is not tied up. They will generally engage if the deal is of good quality and a good fit.  Even if the deal goes away, you will have established a connection with the investor.  Ideally, you are able to get a better understanding of their investment criteria and negotiate terms of engagement with them for the next deal.  This will save a lot of time when the next deal comes around.
• Raise funds specifically to tie up deals. These funds can come from the GP, friends and family, Platform funds, Co-GP investors or an increasingly popular vehicle, a GP fund.  

We’ll cover these options in more detail as we progress through later chapters, but for this project Sam will focus on both the real estate project funding and winning the deal simultaneously.

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